Rethinking Retirement in Bear Times

Thinking of retiring soon? It could be time to adjust your expectations.

The current bear market is wreaking havoc on nearly every investment portfolio, but it may be inflicting its greatest pain on those about to retire or those who are recently retired.

The early years of retirement are generally the worst time for an investor to suffer through a major market decline.

A recent study by the mutual fund firm T. Rowe Price found that poor portfolio performance in the first five years of retirement significantly increases the chances a retired person outlives his or her money over a 30-year retirement period.

Should the current market turmoil persist, those looking to tap into their retirement portfolios for the first time will face a new reality requiring tough decisions.

In many cases, retirement will still be possible, but it may not be the retirement envisioned. It may be a retirement with part-time work, delayed Social Security or fewer trips to fa away destinations.

Frank Boucher, a financial planner in Reston, Va., says "cash is king" if you are retiring, and the market is headed in the wrong direction.

"If you plan to retire soon, you should be building cash reserves in your 401(k) and your taxable investments," he says. "Use this cash to fund your retirement needs while the market recovers."

If you're short of cash, Boucher says, "consider working a little longer or maybe getting a part-time job to reduce your dependence on deflated investments. If doing this doesn't fit in with your retirement plans, you can change those plans. This is your retirement. If you would rather retire now and play golf but worry about money, that's your choice. On the other hand, you may choose to retire now, play a little less golf and sleep better.

To understand why the worst time for a portfolio to sustain major declines is in the early years of retirement, consider the following scenario.

Let's assume you retire with $500,000 in an IRA from which you plan to withdraw 4 percent at the start of each year to help supplement your income. Your first-year withdrawal would be $20,000.

If you then went on to earn a 6 percent return on the remaining $480,000 in that first year of retirement, you would end the year with $508,800, ahead of where you started retirement.

Your second 4 percent withdrawal would then amount to $20,352, leaving you with $488,448. Earn another 6 percent return on that amount, and you would end year two of retirement with $517,755, again ahead of where you started. Retirement's going great.

But now let's assume something far worse.

You retire with your $500,000 IRA and make your first 4 percent withdrawal of $20,000 at the start of the year, again leaving you with $480,000. Then in that first year, your remaining portfolio loses 15 percent of its value as the stock market suffers a decline like the one we're experiencing now. In this case, you would end your first year of retirement with $408,000 -- down $92,000 from where you started.

Then it comes time to make your second annual 4 percent withdrawal and you take only $16,320 from your portfolio. Maybe you adjust for a year by lowering vacation expenses, but your portfolio now is down to $391,680.

Now, what if your portfolio declines in value again in the second year of retirement? Even if it's just a 5 percent drop, you would end year two of retirement with $372,096 in your IRA. Suddenly, retirement is not going so well.